Skip to content

ACCA Strategic Professional · Advanced Financial Management · Application of option pricing theory in investment decisions

A European call option on a non-dividend-paying share has an exercise price of $62 and expires in six months. The share price is $60, the continuously compounded risk-free rate is 4% a year (e^-0.02 = 0.9802), and the call is priced at $5.00. Using put-call parity, the value of a European put with the same exercise price and expiry is closest to:

The put is worth about $5.77. Put-call parity gives put = call minus share price plus the present value of the exercise price: 5.00 - 60 + 60.77. The exercise price must be discounted at the continuously compounded risk-free rate for six months.

  1. A$5.77Correct
  2. B$7.00
  3. C$4.23
  4. D$3.00

Explanation

P = C - S + X e^-rt = 5.00 - 60 + 62 x 0.9802 = 5.00 - 60 + 60.77 = $5.77. Using the undiscounted exercise price gives $7.00. Reversing the signs on the share and exercise price gives $4.23. Ignoring discounting and the time value gives $3.00, which is wrong.

Did you get it right without looking?

One question tells you little. A timed set on Application of option pricing theory in investment decisions shows your real accuracy, how long you take and where you lose marks.

Practise Application of option pricing theory in investment decisionsFree diagnostic mock

More Application of option pricing theory in investment decisions questions